Why aren’t hotter temperatures enough to help natural gas prices?

Market Realist

Demand for natural gas rises in the summer, when power plants generate more electricity to fuel cooling needs

Natural gas is a major fuel used in electricity generation, so demand increases in the summer, when air conditioning uses more electricity. Hotter-than-normal weather can increase natural gas use and consequently natural gas prices. For example, during the summer of 2012, much of the United States experienced record-hot temperatures. Cooling degree days from the week ended May 5 through the week ended September 29 totaled 1,311 compared to an average of 1,079. During that period, natural gas prices rallied from ~$2.30 per MMBtu (millions of British thermal units) to ~$3.30 per MMBtu, partially due to the unusually hot summer. Natural gas price movements especially affect the earnings of major domestic natural gas producers such as Chesapeake Energy (CHK), Range Resources (RRC), Quicksilver Resources (KWK), and Southwestern Energy (SWN). Additionally, many of these companies are part of the energy exchange-traded funds such as the Vanguard Energy ETF (VDE).

Temperatures have been hotter than average

For the week ending July 13, cooling degree days for the United States totaled 84 versus the normal figure for corresponding weeks in the past of 72. Cooling degree days (CDD) measure how much warmer than room temperature the weather is, and the greater the CDD figure, the hotter it is. This week’s CDD figure was higher than normal, meaning weather was hotter than normal, which implies more natural gas demand and therefore higher natural gas prices. On July 12, natural gas prices finished roughly flat at $3.64 per MMBtu compared to $3.62 per MMBtu on July 5, as inventories were in line with expectations (see Why natural gas prices remain depressed, with no help from storage report). Despite hotter temperatures, natural gas demand might be mitigated by power plants using relatively more coal than gas compared to before (see Why natural gas continues to lose market share to coal).

Theoretically, higher demand translates into higher natural gas prices, which affects the earnings and valuations of natural gas–weighted producers. The graph below displays natural gas prices over time versus the stock prices of CHK and KWK, two producers whose production is currently weighted towards natural gas. Over the past few years, the equity prices of these companies have trended with natural gas prices.

Why should investors monitor the weather?

Investors with holdings in natural gas–weighted producers (such as CHK, KWK, RRC, and SWN) or a natural gas ETF such as UNG may find it prudent to monitor the weather as an indicator of natural gas demand and therefore price. This past week’s hotter than normal weather was a positive short-term catalyst for natural gas and also natural gas producers, though prices traded flat on inventory figures. Hotter weather later in the summer could boost natural gas prices.

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